Annuity cost: what you are really paying for

How to get quotations you can actually compare

1. Fix the pot and the date. Every quotation must be for the same amount on the same day, because insurers reprice as yields move. A figure from three weeks ago is not comparable with one from today and the difference is not the insurer being generous.
2. Fix the shape before you shop. Single or joint life, level or escalating, and any guarantee period. These change the starting income far more than the choice of insurer does, so comparing insurers on different shapes measures nothing.
3. Disclose health and lifestyle. An enhanced annuity pays more where medical or lifestyle factors shorten expected life. Insurers differ widely in what they treat as relevant, so the same disclosure produces different uplifts and it is the main reason to shop around.
4. Use the open market option. You are not obliged to buy from the provider that holds the pot. Taking the quotation to the wider market is the single step most likely to change the number, and it costs nothing to ask.

Why the same pot buys different incomes

An annuity is an insurance contract. The insurer takes your capital, invests it in long dated assets and pays you an income until you die, so the price of the promise depends on what it can earn and on how long it expects to pay. When long term yields rise, the income a given pot buys rises with them. When they fall it falls.

That is why a quotation has a short shelf life and why comparing a figure quoted today with one quoted last month tells you nothing about which insurer is better. Two insurers quoting on the same day differ because they hold different views on longevity and on their own costs, not because one has found free money.

The choices that move the number most

Four decisions change the starting income more than the choice of provider. A joint life annuity that continues to a surviving partner pays less at outset than a single life one. An escalating annuity that rises each year starts materially below a level one. A guarantee period that pays out for a fixed term whatever happens costs something. And age matters, because a later start means fewer expected payments.

None of these is better than the others in the abstract. They are trades between income now and protection later, and the right trade depends on facts about your household that this site does not know and does not ask for.

What is not included in the figure

The quoted income is gross. Money taken from a pension is taxable as income, and GOV.UK sets out that you pay tax when you take money out of a pension, so the amount reaching your bank account depends on your other income in the same year.

The tax free element is taken before the annuity is bought, not out of the income. HMRC's guidance on GOV.UK states that you can usually take up to 25 percent of a pension as a tax free lump sum, capped at a lump sum allowance of 268,275 pounds, and it is the remainder that buys the annuity. A quotation on the full pot is answering a different question from a quotation on the pot after the lump sum.

Common questions

Is an annuity rate the same as an interest rate?

No. An annuity rate is the percentage of your pot paid out as income each year for life, so it includes the gradual return of your own capital as well as investment return. That is why annuity rates look higher than deposit rates and why the two cannot be compared directly.

Does taking the tax free lump sum reduce the annuity?

Yes, because the annuity is bought with what is left. HMRC's guidance on GOV.UK states that you can usually take up to 25 percent of a pension tax free, up to a lump sum allowance of 268,275 pounds, and the remaining fund is what the insurer prices. A quotation on the whole pot is not the income you would receive if you had taken the lump sum.

Can I change an annuity after I buy it?

Generally no. A lifetime annuity is a permanent exchange of capital for income, which is the reason the shape decisions matter so much at the point of purchase. That permanence is also what makes it worth taking quotations from more than one insurer before committing.

Does this site sell annuities?

No. It sets out how the cost is arrived at and passes an enquiry to a firm authorised to advise on and arrange one. It does not advise, does not arrange and does not recommend an insurer, and it is paid as an introducer for the introduction rather than by any insurer for a placement.

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